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The dawn of mandatory disclosures

New FAR Rule Authorizes Suspension or Debarment for Contractors that Fail to Comply with Mandatory Disclosures; Extends Code of Business Ethics and Conduct Requirement to Commercial Item Contractors

The FAR councils issued today (November 12, 2008) a sweeping new final rule requiring Government contractors to disclose violations of Federal criminal law in connection with a Federal contract, violations of the civil False Claims Act, and significant overpayments on a contract. Contractors who knowingly fail to report these violations or overpayments when a principal officer or employee has "credible evidence" may face suspension or debarment. See 73 Fed. Reg. 67,064-67,093 (Nov. 12, 2008), available at http://www.pubklaw.com/facs/fac2005-28.pdf . The rule is effective December 12, 2008. The FAR councils believed that the new rule was necessary because although "[t]here is no doubt that mandatory disclosure is a 'sea change' and 'major departure' from voluntary disclosure . . . DoJ and the OIGs point out that the policy of voluntary disclosure has been largely ignored by contractors for the past 10 years."

In addition, the Final Rule extends the code of business ethics and conduct requirement in FAR Clause 52.203-13 to commercial item contracts and establishes minimum requirements for a contractor's internal control system also required by that clause, though commercial item contractors are still exempted from the internal control requirements. See also http://www.wileyrein.com/publication_newsletters.cfm?id=9&publication_id=13384 . The code of business ethics and conduct clause is also a mandatory flow-down for subcontractors. The final rule also amends the FAR to include "the contractor's record of integrity and business ethics" as relevant past performance information for future source selection purposes.

A. Potential Suspension or Debarment for Knowing Failure to Report

The most significant part of the final rule are provisions that create new bases for suspension or debarment in FAR 9.406-2 and 9.407-2, including:

(vi) Knowing failure by a principal, until 3 years after final payment on any Government contract awarded to the contractor, to timely disclose to the Government, in connection with the award, performance, or closeout of the contract or a subcontract thereunder, credible evidence of-

(A) Violation of Federal criminal law involving fraud, conflict of interest, bribery, or gratuity violations found in Title 18 of the United States Code;

(B) Violation of the civil False Claims Act (31 U.S.C. 3729-3733); or

(C) Significant overpayment(s) on the contract, other than overpayments resulting from contract financing payments as defined in 32.001.

In response to criticism of the initial proposed rule that knowledge of lower-level employees could be imputed too far up the corporate chain, the Final Rule defines "principal" to mean "an officer, director, owner, partner, or a person having primary management or supervisory responsibilities within a business entity."

In addition to the new suspension and debarment provisions, the Final Rule modified FAR Clause 52.203-13 to include a mandatory reporting requirement to the agency Office of Inspector General (with a copy to the contracting officer) any time that a Government contractor has "credible evidence" that a principal, employee, agent, or subcontractor of the contractor violated criminal law involving fraud, conflict of interest, bribery, or gratuity violations, or violated the False Claims Act. The "credible evidence" standard was intended to reflect a higher standard of knowledge than the "reasonable grounds to believe" that had been used in the initial proposed rule, and the FAR councils noted that the implication of this higher standard is "that the contractor will have the opportunity to take some time for preliminary examination of the evidence to determine its credibility before deciding to disclose to the Government."

B. Code of Business Conduct and Ethics Extended to Commercial Item Contractors

The second major change in the Final Rule is the removal of an exception in FAR 3.1004 that exempted commercial item contracts and contracts being performed entirely "outside the United States" from the requirement that FAR Clause 52.203-13 be included in all contracts greater than $5 million with a period of performance greater than 120 days. This part of the rule was prompted by a June 2008 statutory requirement (P.L. 110-252, Title VI, Chap.1, "Close the Contractor Fraud Loophole Act."). Although commercial item contractors will remain exempt from the requirement to implement an "internal control system," see FAR 52.203-13(c), they will now have to maintain a written code of business ethics and conduct pursuant to FAR 52.203-13(b) if they hold a contract covered by FAR 3.1004(a). Although commercial item contractors will not be required to implement business ethics awareness and compliance programs, they will remain subject to the new suspension and debarment provisions discussed above.

C. Mandatory Internal Control System Requirements

Finally, the Final Rule implements new minimum requirements for the internal control system required by FAR 52.203-13(c). Previously, the FAR provided several "examples" of components contractors should consider for their internal control system, but the new rule identifies "minimum" requirements. These requirements include, among others, mandatory disclosure procedures, monitoring and auditing, and an internal reporting mechanism to detect criminal conduct.

These new rules are extensive and will likely impose new burdens on all Government contractors. Wiley Rein will soon prepare a more thorough analysis of this Final Rule, as well as its implications on the industry.